Ranking 101 Dividend Champions on Returns & Volatility - 8523 views

By Scott's InvestmentsContributor
10/10/11 - 05:44 PM EDT

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NEW YORK (Scott's Investments) -- I frequently highlight DRIP Investing's monthly Dividend Champion list on Scott's Investments, including a portfolio of high-yield dividend champions, which is up 8.72% since December 2010. The Dividend Champions are stocks that have increased their dividend payout for at least 25 consecutive years.

There has been some recent research, such as the Minimum Variance Portfolios tracked at betaarbitrage.com, which shows that lower volatility stocks have performed better that the overall equity market as gauged by the S&P 500. This should not come as much of a surprise since equities have been in a secular bear market since 2001 and a lower volatility portfolio should fluctuate less than the overall market, which, in a bear market, theoretically means smaller losses.

It is possible to incorporate volatility into our Dividend Champion analysis. The goal is to identify stocks which a) have a long history of increasing dividend payouts and b) have a recent history of low volatility or a history of high risk-adjusted returns. For the purpose of this article, the goal is not to identify high yield, but this is certainly something I may explore in a future article.

Using a custom excel spreadsheet containing price data for the current Dividend Champions, I began by calculating the historical volatility over the past 63, 126, and 252 trading days of each Dividend Champion. I chose these days to correspond closely to three-, six- and 12-month timeframe. These may be unorthodox time frames, but the goal is to identify stocks with lower volatility over longer time periods and to smooth volatility percentages over multiple time frames.

I then averaged the three volatility numbers and used these values to assign a volatility rank to each Dividend Champion. The higher the rank, the lower average historical volatility over 63, 126 and 252 days.

Below are the 10 lowest volatility Dividend Champions using this method:

Next, I took the return data for the current Dividend Champion lists and averaged the dividend adjusted returned over the past 63, 126 and 252 trading days and assigned a rank to each stock. The higher the ranking, the higher the stock's momentum has been over the average of the past 63, 126 and 252 trading days. The 10 highest-returning stocks are below (note: HGIC has agreed to be acquired by Nationwide):

Finally, I calculated the risk-adjusted returns (calculated as the returns divided by the historical volatility) for each Dividend Champion over the past 63, 126 and 252 trading days. These three values were then averaged and each stock was assigned a risk-adjusted return ranking. The higher the historical risk-adjusted return, the higher the ranking. Below are the top 10 Dividend Champions using this method:

Four of the top 10 lowest-volatility Dividend Champion stocks are also holdings in the High Yield Dividend Champion Portfolio I track monthly and which uses a completely different method for selecting Dividend Champion stocks.

If investors want to decrease volatility further and increase income, one additional strategy is to sell a covered call. Using Born to Sell , a McDonalds (MCD) November 95 call closed last week with .36 bid / .39 ask while the stock closed at $87.20. The Johnson & Johnson (JNJ) November $67.50 call closed last week with a .35 bid / .37 ask.

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